Vanguard Tax-Managed Funds Prospectus

Transcription

1 Vanguard Tax-Managed Funds Prospectus April 8, 2016 Admiral Shares Vanguard Tax-Managed Balanced Fund Admiral Shares (VTMFX) Vanguard Tax-Managed Capital Appreciation Fund Admiral Shares (VTCLX) Vanguard Tax-Managed Small-Cap Fund Admiral Shares (VTMSX) This prospectus contains financial data for the Funds through the fiscal year ended December 31, The Securities and Exchange Commission (SEC) has not approved or disapproved these securities or passed upon the adequacy of this prospectus. Any representation to the contrary is a criminal offense.

2 Contents Vanguard Fund Summaries Investing With Vanguard 36 Tax-Managed Balanced Fund 1 Purchasing Shares 36 Tax-Managed Capital Appreciation Fund 6 Converting Shares 39 Tax-Managed Small-Cap Fund 10 Redeeming Shares 40 Investing in Tax-Managed Funds 14 Exchanging Shares 43 More on the Funds 15 Frequent-Trading Limitations 44 The Funds and Vanguard 25 Other Rules You Should Know 46 Investment Advisor 26 Fund and Account Updates 50 Dividends, Capital Gains, and Taxes 27 Contacting Vanguard 52 Share Price 29 Additional Information 53 Financial Highlights 32 Glossary of Investment Terms 55

3 Vanguard Tax-Managed Balanced Fund Investment Objective The Fund seeks to provide a tax-efficient investment return consisting of federally taxexempt income, long-term capital appreciation, and a modest amount of taxable current income. Fees and Expenses The following table describes the fees and expenses you may pay if you buy and hold shares of the Fund. Shareholder Fees (Fees paid directly from your investment) Sales Charge (Load) Imposed on Purchases Purchase Fee Sales Charge (Load) Imposed on Reinvested Dividends Redemption Fee Account Service Fee (for certain fund account balances below $10,000) None None None None $20/year Annual Fund Operating Expenses (Expenses that you pay each year as a percentage of the value of your investment) Management Fees 0.10% 12b-1 Distribution Fee None Other Expenses 0.01% Total Annual Fund Operating Expenses 0.11% Example The following example is intended to help you compare the cost of investing in the Fund with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invested $10,000 in the Fund s shares. This example assumes that the Fund provides a return of 5% each year and that total annual fund operating expenses remain as stated in the preceding table. You would incur these hypothetical expenses whether or not you redeem your investment at the end of the given period. Although your actual costs may be higher or lower, based on these assumptions your costs would be: 1 Year 3 Years 5 Years 10 Years $11 $35 $62 $141 1

4 Portfolio Turnover The Fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover rate may indicate higher transaction costs and may result in more taxes when Fund shares are held in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the previous expense example, reduce the Fund s performance. During the most recent fiscal year, the Fund s portfolio turnover rate was 9% of the average value of its portfolio. Principal Investment Strategies The Fund invests approximately 50% to 55% of its assets in municipal securities and the balance in common stocks. The fixed income portion of the Fund is concentrated in high-quality municipal securities with a dollar-weighted average maturity expected to be between 6 and 12 years. At least 75% of the municipal bonds purchased by the Fund will be rated in one of the top three credit-rating categories as determined by an independent bond-rating agency (e.g., Aaa, Aa, and A by Moody s Investors Service, Inc., or AAA, AA, and A by Standard & Poor s) or, if unrated, determined to be of comparable quality by the advisor. The Fund s stock holdings are chosen from the stocks that pay lower dividends within the Russell 1000 Index an index that is made up of stocks of large- and midcapitalization U.S. companies. The Fund uses statistical methods to sample the Index, aiming to minimize taxable dividends while approximating the other characteristics of the Index. The intended result is a portfolio that will loosely track the total return performance of the Index, but with lower taxable income distributions. Principal Risks The Fund is subject to the risks associated with the stock and bond markets, any of which could cause an investor to lose money. However, because stock and bond prices can move in different directions or to different degrees, the Fund s bond holdings may counteract some of the volatility experienced by the Fund s stock holdings. With 50% to 55% of its assets in municipal securities, the Fund is proportionately subject to bond risks, including the following: interest rate risk, which is the chance that bond prices overall will decline because of rising interest rates; credit risk, which is the chance that a bond issuer will fail to pay interest or principal in a timely manner or that negative perceptions of the issuer s ability to make such payments will cause the price of that bond to decline; call risk, which is the chance that during periods of falling interest rates, issuers of callable bonds may call (redeem) securities with higher coupon rates or interest rates before their maturity dates, causing the Fund to lose any price appreciation above the bond s call price and forcing it to reinvest the unanticipated proceeds at lower interest rates that may result in a decline in the Fund s income; income risk, which 2

5 is the chance that the Fund s income will decline because of falling interest rates; liquidity risk, which is the chance that the Fund may not be able to sell a security in a timely manner at a desired price; manager risk, which is the chance that poor security selection will cause the Fund to underperform relevant benchmarks or other funds with a similar investment objective; and tax risk, which is the chance that all or a portion of the tax-exempt income from municipal bonds held by the Fund will be declared taxable, possibly with retroactive effect, because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state or local tax authorities, or noncompliant conduct of a bond issuer. With 45% to 50% of its assets in stocks, the Fund is proportionately subject to stock risks, including stock market risk and investment style risk. Stock market risk is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. The benchmark index for the stock portion of the Fund tracks a subset of the U.S. stock market, which could cause the Fund to perform differently from the overall stock market. In addition, the Fund s benchmark index may, at times, become focused in stocks of a particular market sector, which would subject the Fund to proportionately higher exposure to the risks of that sector. Investment style risk is the chance that returns from large- and midcapitalization stocks will trail returns from the overall stock market. Large- and mid-cap stocks each tend to go through cycles of doing better or worse than other segments of the stock market or the stock market in general. These periods have, in the past, lasted for as long as several years. Historically, mid-cap stocks have been more volatile in price than large-cap stocks because, among other things, mid-size companies are more sensitive to changing economic conditions. An investment in the Fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Annual Total Returns The following bar chart and table are intended to help you understand the risks of investing in the Fund. The bar chart shows how the performance of the Fund has varied from one calendar year to another over the periods shown. The table shows how the average annual total returns of the Fund compare with those of relevant market indexes and a composite bond/stock index, which have investment characteristics similar to those of the Fund. Keep in mind that the Fund s past performance (before and after taxes) does not indicate how the Fund will perform in the future. Updated performance information is available on our website at vanguard.com/performance or by calling Vanguard toll-free at

6 Annual Total Returns Vanguard Tax-Managed Balanced Fund Admiral Shares % 40% 20% 0% -20% -40% -60% During the periods shown in the bar chart, the highest return for a calendar quarter was 10.46% (quarter ended September 30, 2009), and the lowest return for a quarter was 9.01% (quarter ended December 31, 2008). Average Annual Total Returns for Periods Ended December 31, Year 5 Years 10 Years Vanguard Tax-Managed Balanced Fund Admiral Shares Return Before Taxes 2.35% 8.51% 6.25% Return After Taxes on Distributions Return After Taxes on Distributions and Sale of Fund Shares Comparative Indexes (reflect no deduction for fees, expenses, or taxes) Russell 1000 Index 0.92% 12.44% 7.40% Tax-Managed Balanced Composite Index Barclays 1-15 Year Municipal Bond Index Actual after-tax returns depend on your tax situation and may differ from those shown in the preceding table. When after-tax returns are calculated, it is assumed that the shareholder was in the highest individual federal marginal income tax bracket at the time of each distribution of income or capital gains or upon redemption. State and local income taxes are not reflected in the calculations. Please note that after-tax returns are not relevant for a shareholder who holds fund shares in a tax-deferred account, such as an individual retirement account or a 401(k) plan. Also, figures captioned Return After Taxes on Distributions and Sale of Fund Shares may be higher than other figures for the same period if a capital loss occurs upon redemption and results in an assumed tax deduction for the shareholder. 4

7 Investment Advisor The Vanguard Group, Inc. (Vanguard) Portfolio Managers James M. D Arcy, CFA, Portfolio Manager at Vanguard. He has managed the bond portion of the Fund since Donald M. Butler, CFA, Principal of Vanguard. He has co-managed the stock portion of the Fund since William Coleman, Portfolio Manager at Vanguard. He has co-managed the stock portion of the Fund since Purchase and Sale of Fund Shares You may purchase or redeem shares online through our website (vanguard.com), by mail (The Vanguard Group, P.O. Box 1110, Valley Forge, PA ), or by telephone ( ). The minimum investment amount required to open and maintain a Fund account for Admiral Shares is $10,000. The minimum investment amount required to add to an existing Fund account is generally $1. Institutional, financial intermediary, and Vanguard retail managed clients should contact Vanguard for information on special eligibility rules that may apply to them regarding Admiral Shares. Tax Information The Fund s distributions may be taxable as ordinary income or capital gain. The dividends that you receive from the Fund that are attributable to interest paid on the Fund s investments in municipal securities are generally expected to be exempt from federal income taxes. The Fund s other distributions are expected to be subject to federal, state, and/or local income taxes. Payments to Financial Intermediaries The Fund and its investment advisor do not pay financial intermediaries for sales of Fund shares. 5

8 Vanguard Tax-Managed Capital Appreciation Fund Investment Objective The Fund seeks to provide a tax-efficient investment return consisting of long-term capital appreciation. Fees and Expenses The following table describes the fees and expenses you may pay if you buy and hold Admiral Shares of the Fund. Shareholder Fees (Fees paid directly from your investment) Sales Charge (Load) Imposed on Purchases Purchase Fee Sales Charge (Load) Imposed on Reinvested Dividends Redemption Fee Account Service Fee (for certain fund account balances below $10,000) None None None None $20/year Annual Fund Operating Expenses (Expenses that you pay each year as a percentage of the value of your investment) Management Fees 0.10% 12b-1 Distribution Fee None Other Expenses 0.01% Total Annual Fund Operating Expenses 0.11% Example The following example is intended to help you compare the cost of investing in the Fund s Admiral Shares with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invested $10,000 in the Fund s shares. This example assumes that the Shares provide a return of 5% each year and that total annual fund operating expenses remain as stated in the preceding table. You would incur these hypothetical expenses whether or not you redeem your investment at the end of the given period. Although your actual costs may be higher or lower, based on these assumptions your costs would be: 1 Year 3 Years 5 Years 10 Years $11 $35 $62 $141 6

9 Portfolio Turnover The Fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover rate may indicate higher transaction costs and may result in more taxes when Fund shares are held in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the previous expense example, reduce the Fund s performance. During the most recent fiscal year, the Fund s portfolio turnover rate was 10% of the average value of its portfolio. Principal Investment Strategies The Fund purchases stocks that pay lower dividends and are included in the Russell 1000 Index an index that is made up of the stocks of large- and mid-capitalization U.S. companies. The Fund uses statistical methods to sample the Index, aiming to minimize taxable dividends while approximating the other characteristics of the Index. The expected result is a portfolio that will loosely track the total return performance of the Index, but with lower taxable income distributions. Principal Risks An investment in the Fund could lose money over short or even long periods. You should expect the Fund s share price and total return to fluctuate within a wide range. The Fund is subject to the following risks, which could affect the Fund s performance: Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. The Fund s benchmark index tracks a subset of the U.S. stock market, which could cause the Fund to perform differently from the overall stock market. In addition, the Fund s benchmark index may, at times, become focused in stocks of a particular market sector, which would subject the Fund to proportionately higher exposure to the risks of that sector. Investment style risk, which is the chance that returns from large- and midcapitalization stocks will trail returns from the overall stock market. Large- and mid-cap stocks each tend to go through cycles of doing better or worse than other segments of the stock market or the stock market in general. These periods have, in the past, lasted for as long as several years. Historically, mid-cap stocks have been more volatile in price than large-cap stocks because, among other things, mid-size companies are more sensitive to changing economic conditions. An investment in the Fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 7

10 Annual Total Returns The following bar chart and table are intended to help you understand the risks of investing in the Fund. The bar chart shows how the performance of the Fund s Admiral Shares has varied from one calendar year to another over the periods shown. The table shows how the average annual total returns of the Admiral Shares compare with those of the Fund s benchmark index, which has investment characteristics similar to those of the Fund. Keep in mind that the Fund s past performance (before and after taxes) does not indicate how the Fund will perform in the future. Updated performance information is available on our website at vanguard.com/performance or by calling Vanguard toll-free at Annual Total Returns Vanguard Tax-Managed Capital Appreciation Fund Admiral Shares % 40% 20% 0% -20% -40% -60% During the periods shown in the bar chart, the highest return for a calendar quarter was 16.74% (quarter ended June 30, 2009), and the lowest return for a quarter was 22.26% (quarter ended December 31, 2008). Average Annual Total Returns for Periods Ended December 31, 2015 Actual after-tax returns depend on your tax situation and may differ from those shown in the preceding table. When after-tax returns are calculated, it is assumed that the shareholder was in the highest individual federal marginal income tax bracket at the time of each distribution of income or capital gains or upon redemption. State and local income taxes are not reflected in the calculations. Please note that after-tax returns are not relevant for a shareholder who holds fund shares in a tax-deferred account, such as 8 1 Year 5 Years 10 Years Vanguard Tax-Managed Capital Appreciation Fund Admiral Shares Return Before Taxes 1.68% 12.52% 7.43% Return After Taxes on Distributions Return After Taxes on Distributions and Sale of Fund Shares Russell 1000 Index (reflects no deduction for fees, expenses, or taxes) 0.92% 12.44% 7.40%

11 an individual retirement account or a 401(k) plan. Also, figures captioned Return After Taxes on Distributions and Sale of Fund Shares may be higher than other figures for the same period if a capital loss occurs upon redemption and results in an assumed tax deduction for the shareholder. Investment Advisor The Vanguard Group, Inc. (Vanguard) Portfolio Managers Donald M. Butler, CFA, Principal of Vanguard. He has co-managed the Fund since William Coleman, Portfolio Manager at Vanguard. He has co-managed the Fund since Purchase and Sale of Fund Shares You may purchase or redeem shares online through our website (vanguard.com), by mail (The Vanguard Group, P.O. Box 1110, Valley Forge, PA ), or by telephone ( ). The minimum investment amount required to open and maintain a Fund account for Admiral Shares is $10,000. The minimum investment amount required to add to an existing Fund account is generally $1. Institutional, financial intermediary, and Vanguard retail managed clients should contact Vanguard for information on special eligibility rules that may apply to them regarding Admiral Shares. Tax Information The Fund s distributions may be taxable as ordinary income or capital gain. Payments to Financial Intermediaries The Fund and its investment advisor do not pay financial intermediaries for sales of Fund shares. 9

12 Vanguard Tax-Managed Small-Cap Fund Investment Objective The Fund seeks to provide a tax-efficient investment return consisting of long-term capital appreciation. Fees and Expenses The following table describes the fees and expenses you may pay if you buy and hold Admiral Shares of the Fund. Shareholder Fees (Fees paid directly from your investment) Sales Charge (Load) Imposed on Purchases Purchase Fee Sales Charge (Load) Imposed on Reinvested Dividends Redemption Fee Account Service Fee (for certain fund account balances below $10,000) None None None None $20/year Annual Fund Operating Expenses (Expenses that you pay each year as a percentage of the value of your investment) Management Fees 0.10% 12b-1 Distribution Fee None Other Expenses 0.01% Total Annual Fund Operating Expenses 0.11% Example The following example is intended to help you compare the cost of investing in the Fund s Admiral Shares with the cost of investing in other mutual funds. It illustrates the hypothetical expenses that you would incur over various periods if you invested $10,000 in the Fund s shares. This example assumes that the Shares provide a return of 5% each year and that total annual fund operating expenses remain as stated in the preceding table. You would incur these hypothetical expenses whether or not you redeem your investment at the end of the given period. Although your actual costs may be higher or lower, based on these assumptions your costs would be: 1 Year 3 Years 5 Years 10 Years $11 $35 $62 $141 10

13 Portfolio Turnover The Fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover rate may indicate higher transaction costs and may result in more taxes when Fund shares are held in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the previous expense example, reduce the Fund s performance. During the most recent fiscal year, the Fund s portfolio turnover rate was 33% of the average value of its portfolio. Principal Investment Strategies The Fund purchases stocks included in the Standard & Poor s SmallCap 600 Index an index that is made up of stocks of smaller U.S. companies in approximately the same proportions as in the Index. To improve tax efficiency, the Fund may limit investments in Index securities that have undesirable tax characteristics and may continue to hold securities no longer included in the Index. Principal Risks An investment in the Fund could lose money over short or even long periods. You should expect the Fund s share price and total return to fluctuate within a wide range. The Fund is subject to the following risks, which could affect the Fund s performance: Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. The Fund s benchmark index tracks a subset of the U.S. stock market, which could cause the Fund to perform differently from the overall stock market. In addition, the Fund s benchmark index may, at times, become focused in stocks of a particular market sector, which would subject the Fund to proportionately higher exposure to the risks of that sector. Investment style risk, which is the chance that returns from small-capitalization stocks will trail returns from the overall stock market. Historically, small-cap stocks have been more volatile in price than the large-cap stocks that dominate the overall market, and they often perform quite differently. Small companies tend to have greater stock volatility because, among other things, these companies are more sensitive to changing economic conditions. An investment in the Fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. 11

14 Annual Total Returns The following bar chart and table are intended to help you understand the risks of investing in the Fund. The bar chart shows how the performance of the Fund s Admiral Shares has varied from one calendar year to another over the periods shown. The table shows how the average annual total returns of the Admiral Shares compare with those of the Fund s benchmark index, which has investment characteristics similar to those of the Fund. Keep in mind that the Fund s past performance (before and after taxes) does not indicate how the Fund will perform in the future. Updated performance information is available on our website at vanguard.com/performance or by calling Vanguard toll-free at Annual Total Returns Vanguard Tax-Managed Small-Cap Fund Admiral Shares % 40% 20% 0% -20% -40% -60% During the periods shown in the bar chart, the highest return for a calendar quarter was 21.02% (quarter ended June 30, 2009), and the lowest return for a quarter was 24.79% (quarter ended December 31, 2008). Average Annual Total Returns for Periods Ended December 31, 2015 Actual after-tax returns depend on your tax situation and may differ from those shown in the preceding table. When after-tax returns are calculated, it is assumed that the shareholder was in the highest individual federal marginal income tax bracket at the time of each distribution of income or capital gains or upon redemption. State and local income taxes are not reflected in the calculations. Please note that after-tax returns are not relevant for a shareholder who holds fund shares in a tax-deferred account, such as 12 1 Year 5 Years 10 Years Vanguard Tax-Managed Small-Cap Fund Admiral Shares Return Before Taxes 1.85% 11.54% 8.05% Return After Taxes on Distributions Return After Taxes on Distributions and Sale of Fund Shares S&P SmallCap 600 Index (reflects no deduction for fees, expenses, or taxes) 1.97% 11.48% 8.01%

15 an individual retirement account or a 401(k) plan. Also, figures captioned Return After Taxes on Distributions and Sale of Fund Shares may be higher than other figures for the same period if a capital loss occurs upon redemption and results in an assumed tax deduction for the shareholder. Investment Advisor The Vanguard Group, Inc. (Vanguard) Portfolio Managers Donald M. Butler, CFA, Principal of Vanguard. He has co-managed the Fund since William Coleman, Portfolio Manager at Vanguard. He has co-managed the Fund since Purchase and Sale of Fund Shares You may purchase or redeem shares online through our website (vanguard.com), by mail (The Vanguard Group, P.O. Box 1110, Valley Forge, PA ), or by telephone ( ). The minimum investment amount required to open and maintain a Fund account for Admiral Shares is $10,000. The minimum investment amount required to add to an existing Fund account is generally $1. Institutional, financial intermediary, and Vanguard retail managed clients should contact Vanguard for information on special eligibility rules that may apply to them regarding Admiral Shares. Tax Information The Fund s distributions may be taxable as ordinary income or capital gain. Payments to Financial Intermediaries The Fund and its investment advisor do not pay financial intermediaries for sales of Fund shares. 13

16 Investing in Tax-Managed Funds Most mutual funds seek to maximize pre-tax total returns, without regard to the personal tax consequences for investors. Yet most investors stand to lose a significant portion of their investment returns to federal, state, and local taxes. Fund dividends and short-term capital gains are now taxed at federal income tax rates as high as 39.6%; for long-term capital gains and certain qualified dividends, the rates can be up to 20%. The Funds offered in this prospectus aim to minimize the impact of taxes on investors total returns by operating in a tax-efficient manner. Each Fund uses the following taxmanagement techniques: Lower turnover. Each Fund seeks to minimize turnover by employing an indexoriented approach to stock investing. Frequent trading a hallmark of many actively managed funds causes a fund to realize capital gains, which must then be distributed to shareholders, reducing after-tax returns. A disciplined sell-selection method. When selling specific securities, each Fund will select a specific share lot more often than not, the highest-cost shares in order to minimize realized capital gains. In addition, the Fund may sell securities at a loss in order to offset realized capital gains that would otherwise have to be distributed to shareholders. Bias against taxable dividend income. The Tax-Managed Balanced and Tax-Managed Capital Appreciation Funds minimize taxable dividend income by focusing on the stocks that pay lower dividends in their shared benchmark index (the Russell 1000 Index). In addition, the bond portion of the Tax-Managed Balanced Fund is made up of municipal bonds, which generate federally tax-exempt dividends. The Funds tax-management techniques may reduce an investor s taxable income but will not eliminate it. Because tax consequences are considered in managing the Funds, a Fund s pre-tax performance may be lower than that of a similar fund that is not tax-managed. 14

17 More on the Funds This prospectus describes the principal risks you would face as a Fund shareholder. It is important to keep in mind one of the main axioms of investing: generally, the higher the risk of losing money, the higher the potential reward. The reverse, also, is generally true: the lower the risk, the lower the potential reward. As you consider an investment in any mutual fund, you should take into account your personal tolerance for fluctuations in the securities markets. Look for this symbol throughout the prospectus. It is used to mark detailed information about the more significant risks that you would confront as a Fund shareholder. To highlight terms and concepts important to mutual fund investors, we have provided Plain Talk explanations along the way. Reading the prospectus will help you decide whether a Fund is the right investment for you. We suggest that you keep this prospectus for future reference. Share Class Overview This prospectus offers the Funds Admiral Shares. A separate prospectus offers Institutional Shares for each Fund (other than the Tax-Managed Balanced Fund), which are generally for investors who invest a minimum of $5 million. Both share classes offered by a Fund have the same investment objective, strategies, and policies. However, different share classes have different expenses; as a result, their investment performances will differ. Plain Talk About Costs of Investing Costs are an important consideration in choosing a mutual fund. That is because you, as a shareholder, pay a proportionate share of the costs of operating a fund, plus any transaction costs incurred when the fund buys or sells securities. These costs can erode a substantial portion of the gross income or the capital appreciation a fund achieves. Even seemingly small differences in expenses can, over time, have a dramatic effect on a fund s performance. The following sections explain the principal investment strategies and policies that each Fund uses in pursuit of its objective. The Funds board of trustees, which oversees each Fund s management, may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. Note that each Fund s investment objective is not fundamental and may be changed without a shareholder vote. 15

18 Vanguard Tax-Managed Small-Cap Fund will invest all, or substantially all (but in no event less than 80%), of its assets in small-cap stocks, which include those stocks in the S&P SmallCap 600 Index. This policy may be changed only upon 60 days notice to shareholders. The Fund s investment in small-cap stocks generally will be within the capitalization range of the companies included in the S&P SmallCap 600 Index ($59 million to $4.5 billion, as of December 31, 2015). In the future, the Index s market capitalization range may be higher or lower, or the Fund s investment may follow a different small-cap index universe. Such changes may occur at any time and without notice to Fund shareholders. Market Exposure The following grid shows, at a glance, the types of investments made by each Fund as its principal investment strategy, as well as the percentage of assets that each Fund expects to allocate to these investments. Market exposure is expected to play the most important role in achieving a Fund s investment objective. Market Exposure Common stocks Tax-Managed Balanced 45% 50% Largeand mid-cap U.S. companies Vanguard Fund Tax-Managed Capital Appreciation 100% Large- and mid-cap U.S. companies Municipal bonds 50% 55% None None Tax-Managed Small-Cap 100% Small-cap U.S. companies U.S. Stocks Each Fund invests in U.S. stocks as a principal investment strategy. The size of the companies on which the Funds focus differs with each Fund. Each Fund is subject to stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Each Fund s benchmark index tracks a subset of the U.S. stock market, which could cause the Fund to perform differently from the overall stock market. In addition, each Fund s benchmark index may, at times, become focused in stocks of a particular market sector, which would subject the Fund to proportionately higher exposure to the risks of that sector. To illustrate the volatility of stock prices, the following table shows the best, worst, and average annual total returns for the U.S. stock market over various periods as measured by the S&P 500 Index, a widely used barometer of U.S. stock market activity. Total returns consist of dividend income plus change in market price. Note 16

19 that the returns shown do not include the costs of buying and selling stocks or other expenses that a real-world investment portfolio would incur. U.S. Stock Market Returns ( ) 1 Year 5 Years 10 Years 20 Years Best 54.2% 28.6% 19.9% 17.8% Worst Average The table covers all of the rolling 1-, 5-, 10-, and 20-year periods from 1926 through You can see, for example, that although the average annual return on common stocks for all of the 5-year periods was 10%, average annual returns for individual 5-year periods ranged from 12.4% (from 1928 through 1932) to 28.6% (from 1995 through 1999). These average annual returns reflect past performance of common stocks; you should not regard them as an indication of future performance of either the stock market as a whole or the Funds in particular. Keep in mind that the S&P 500 Index holds mainly large-cap stocks. Historically, smalland mid-cap stocks have been more volatile than and at times have performed quite differently from large-cap stocks. This volatility is the result of several factors, including, but not limited to, less-certain growth and dividend prospects for smaller companies and greater sensitivity to changing economic conditions. The Tax-Managed Balanced and Tax-Managed Capital Appreciation Funds hold mid-cap stocks in addition to large-cap stocks; the Tax-Managed Small-Cap Fund holds small-cap stocks. Stocks of publicly traded companies and funds that invest in stocks are often classified according to market value, or market capitalization. These classifications typically include small-cap, mid-cap, and large-cap. It is important to understand that, for both companies and stock funds, market-capitalization ranges change over time. Also, interpretations of size vary, and there are no official definitions of small-, mid-, and large-cap, even among Vanguard fund advisors. The asset-weighted median market capitalization of each Fund s stock holdings as of December 31, 2015, was: Vanguard Fund Market Capitalization Tax-Managed Balanced (stock portion) $59.1 billion Tax-Managed Capital Appreciation 56.0 Tax-Managed Small-Cap

20 Each Fund is subject to investment style risk, which is the chance that returns from the types of stocks in which the Fund invests will trail returns from the overall stock market. Specific types of stocks tend to go through cycles of doing better or worse than other segments of the stock market or the stock market in general. These periods have, in the past, lasted for as long as several years. Municipal Securities The Tax-Managed Balanced Fund invests 50% to 55% of its assets in municipal securities. These are bonds, notes, and other fixed income instruments issued by state and local governments and regional governmental authorities, which pay income that is exempt from federal taxes. There is no guarantee that all of the income from municipal bonds will remain exempt from federal, state, or local income taxes. Income from municipal bonds held by the Fund could be declared taxable, possibly with retroactive effect, because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service (IRS) or state or local tax authorities, or noncompliant conduct of a bond issuer. The Fund focuses on high-quality municipal securities: At least 75% of the municipal bonds purchased by the Fund will be rated in one of the top three credit-rating categories as determined by an independent bond-rating agency (e.g., Aaa, Aa, and A by Moody s Investors Service, Inc. (Moody s) or AAA, AA, and A by Standard & Poor s) or, if unrated, determined to be of comparable quality by the advisor. No more than 20% of the Fund s municipal security assets may be invested in bonds rated in the fourth-highest credit rating category (Baa by Moody s or BBB by Standard & Poor s) or, if unrated, determined to be of comparable quality by the advisor. Up to 5% of the Fund s municipal security assets may be invested in securities with lower credit ratings or, if unrated, determined to be of comparable quality by the advisor. The dollar-weighted average maturity of the Fund s municipal securities holdings is expected to be between 6 and 12 years. Plain Talk About Municipal Bonds Municipal bonds are securities issued by state and local governments and regional governmental authorities as a way of raising money for public construction projects (e.g., highways, airports, or housing), for operating expenses, or for loans to public institutions and facilities. 18

21 The Tax-Managed Balanced Fund is subject to interest rate risk, which is the chance that bond prices overall will decline because of rising interest rates. Interest rate risk is moderate for intermediate-term bonds such as those purchased by the Fund. For the Fund overall, interest rate risk should range from low to moderate because it invests only a portion of its assets in bonds. Although bonds are often thought to be less risky than stocks, there have been periods when bond prices have fallen significantly because of rising interest rates. For instance, prices of long-term bonds fell by almost 48% between December 1976 and September To illustrate the relationship between bond prices and interest rates, the following table shows the effect of a 1% and a 2% change (both up and down) in interest rates on the values of three noncallable bonds (i.e., bonds that cannot be redeemed by the issuer) of different maturities, each with a face value of $1,000. How Interest Rate Changes Affect the Value of a $1,000 Bond 1 Type of Bond (Maturity) After a 1% Increase After a 1% Decrease After a 2% Increase After a 2% Decrease Short-Term (2.5 years) $977 $1,024 $954 $1,049 Intermediate-Term (10 years) 922 1, ,180 Long-Term (20 years) 874 1, ,328 1 Assuming a 4% coupon rate. These figures are for illustration only; you should not regard them as an indication of future performance of the bond market as a whole or the Tax-Managed Balanced Fund in particular. Plain Talk About Bonds and Interest Rates As a rule, when interest rates rise, bond prices fall. The opposite is also true: Bond prices go up when interest rates fall. Why do bond prices and interest rates move in opposite directions? Let s assume that you hold a bond offering a 4% yield. A year later, interest rates are on the rise and bonds of comparable quality and maturity are offered with a 5% yield. With higher-yielding bonds available, you would have trouble selling your 4% bond for the price you paid you would probably have to lower your asking price. On the other hand, if interest rates were falling and 3% bonds were being offered, you should be able to sell your 4% bond for more than you paid. 19

22 Changes in interest rates can affect bond income as well as bond prices. The Tax-Managed Balanced Fund is subject to income risk, which is the chance that the Fund s income will decline because of falling interest rates. A fund s income declines when interest rates fall because the fund then must invest new cash flow and cash from maturing bonds in lower-yielding bonds. Income risk is generally higher for funds holding short-term bonds and lower for funds holding long-term bonds. For the Fund overall, income risk should range from low to moderate because it invests only a portion of its assets in bonds. Plain Talk About Bond Maturities A bond is issued with a specific maturity date the date when the issuer must pay back the bond s principal (face value). Bond maturities range from less than 1 year to more than 30 years. Typically, the longer a bond s maturity, the more price risk you, as a bond investor, will face as interest rates rise but also the higher the potential yield you could receive. Longer-term bonds are more suitable for investors willing to take a greater risk of price fluctuations to get higher and more stable interest income. Shorter-term bond investors should be willing to accept lower yields and greater income variability in return for less fluctuation in the value of their investment. The Tax-Managed Balanced Fund is subject to credit risk, which is the chance that a bond issuer will fail to pay interest or principal in a timely manner or that negative perceptions of the issuer s ability to make such payments will cause the price of that bond to decline. Credit risk should be low for the Fund because it invests only a portion of its assets in bonds, most of which are considered to be of high quality. 20

23 Plain Talk About Credit Quality A bond s credit-quality rating is an assessment of the issuer s ability to pay interest on the bond and, ultimately, to repay the principal. Credit quality is evaluated by one or more of the nationally recognized statistical rating organizations (for example, Moody s Investors Service, Inc. (Moody s) or Standard & Poor s) or through independent analysis conducted by a fund s advisor. The lower the rating, the greater the chance in the rating agency s or advisor s opinion that the bond issuer will default, or fail to meet its payment obligations. All things being equal, the lower a bond s credit rating, the higher its yield should be to compensate investors for assuming additional risk. Investment-grade bonds are those rated in one of the four highest ratings categories. A fund may treat an unrated bond as investmentgrade if warranted by the advisor s analysis. The Tax-Managed Balanced Fund is subject to call risk, which is the chance that during periods of falling interest rates, issuers of callable bonds may call (redeem) securities with higher coupon rates or interest rates before their maturity dates. The Fund would then lose any price appreciation above the bond s call price and would be forced to reinvest the unanticipated proceeds at lower interest rates, resulting in a decline in the Fund s income. Such redemptions and subsequent reinvestments would also increase the Fund s portfolio turnover rate. Call risk is generally moderate for intermediate-term bonds such as those purchased by the Fund. For the Fund overall, call risk should range from low to moderate because it invests only a portion of its assets in bonds. The Tax-Managed Balanced Fund is subject to extension risk. Extension risk is the chance that during periods of rising interest rates, certain debt securities will be paid off substantially more slowly than originally anticipated, and the value of those securities may fall. Extension risk should be low for the Fund because it invests only a portion of its assets in bonds. The Tax-Managed Balanced Fund s bond holdings help to reduce but not eliminate some of the stock market volatility experienced by the Fund. Likewise, changes in interest rates may not have as dramatic an effect on the Fund as they would on a fund made up entirely of bonds. The Fund s balanced portfolio, in the long run, should result in less investment risk and a lower investment return than a fund investing exclusively in common stocks. 21

24 The Tax-Managed Balanced Fund is subject to liquidity risk, which is the chance that the Fund may not be able to sell a security in a timely manner at a desired price. Liquidity risk is generally moderate for intermediate-term municipal bond funds. For the Fund overall, liquidity risk should range from low to moderate because it invests only a portion of its assets in municipal bonds. Municipal securities are traded via a network among dealers and brokers that connect buyers with sellers. Liquidity in the tax-exempt bond market has been reduced as a result of overall economic conditions and credit tightening. There may be little trading in the secondary market for particular bonds and other fixed income securities, which may make them more difficult to value or sell. Security Selection Each Fund employs an index-oriented approach to stock investing, and the only stocks purchased by a Fund are those of issuers included in its benchmark index at the time of purchase. The Tax-Managed Balanced Fund selects municipal securities, however, based upon traditional active-management techniques. The following grid shows, at a glance, the types of stocks included in each Fund s benchmark index. Vanguard Fund Benchmark Index Types of Stocks Tax-Managed Balanced (stock portion) Russell 1000 Large- and mid-cap Tax-Managed Capital Appreciation Russell 1000 Large- and mid-cap Tax-Managed Small-Cap S&P SmallCap 600 Small-cap The bond portion of the Tax-Managed Balanced Fund is subject to manager risk, which is the chance that poor security selection will cause the Fund to underperform relevant benchmarks or other funds with a similar investment objective. Other Investment Policies and Risks Each Fund may invest, to a limited extent, in derivatives. Generally speaking, a derivative is a financial contract whose value is based on the value of a financial asset (such as a stock, a bond, or a currency), a physical asset (such as gold, oil, or wheat), a market index (such as the S&P 500 Index), or a reference rate (such as LIBOR). Investments in derivatives may subject the Funds to risks different from, and possibly greater than, those of investments directly in the underlying securities or assets. The Funds will not use derivatives for speculation or for the purpose of leveraging (magnifying) investment returns. 22

25 Vanguard may invest a small portion of each Fund s assets in stock index futures (and, for the Tax-Managed Balanced Fund, U.S. Treasury futures), which are a type of derivative, and/or shares of exchange-traded funds (ETFs). These futures and ETFs typically provide returns similar to those of common stocks (and, for U.S. Treasury futures, bonds). Vanguard may purchase futures or ETFs when doing so will reduce the Fund s transaction costs or provide flexibility for the Fund to seek better tax efficiency. Vanguard receives no additional revenue from Fund assets invested in ETF Shares of other Vanguard funds. Fund assets invested in ETF Shares are excluded when allocating to the Fund its share of the costs of Vanguard operations. Cash Management Each Fund s daily cash balance may be invested in one or more Vanguard CMT Funds, which are very low-cost money market funds. When investing in a Vanguard CMT Fund, each Fund bears its proportionate share of the at-cost expenses of the CMT Fund in which it invests. Vanguard receives no additional revenue from Fund assets invested in a Vanguard CMT Fund. Temporary Investment Measures Each Fund may temporarily depart from its normal investment policies and strategies when the advisor believes that doing so is in the Fund s best interest, so long as the alternative is consistent with the Fund s investment objective. For instance, the Fund may invest beyond its normal limits in derivatives or exchange-traded funds that are consistent with the Fund s objective when those instruments are more favorably priced or provide needed liquidity, as might be the case if the Fund receives large cash flows that it cannot prudently invest immediately. In addition, each Fund may take temporary defensive positions that are inconsistent with its normal investment policies and strategies for instance, by allocating substantial assets to cash equivalent investments or other less volatile instruments in response to adverse or unusual market, economic, political, or other conditions. In doing so, the Fund may succeed in avoiding losses but may otherwise fail to achieve its investment objective. Frequent Trading or Market-Timing Background. Some investors try to profit from strategies involving frequent trading of mutual fund shares, such as market-timing. For funds holding foreign securities, investors may try to take advantage of an anticipated difference between the price of the fund s shares and price movements in overseas markets, a practice also known as time-zone arbitrage. Investors also may try to engage in frequent trading of funds holding investments such as small-cap stocks and high-yield bonds. As money is shifted into and out of a fund by a shareholder engaging in frequent trading, the fund 23

26 incurs costs for buying and selling securities, resulting in increased brokerage and administrative costs. These costs are borne by all fund shareholders, including the long-term investors who do not generate the costs. In addition, frequent trading may interfere with an advisor s ability to efficiently manage the fund. Policies to address frequent trading. The Vanguard funds (other than money market funds and short-term bond funds, but including Vanguard Short-Term Inflation- Protected Securities Index Fund) do not knowingly accommodate frequent trading. The board of trustees of each Vanguard fund (other than money market funds and shortterm bond funds, but including Vanguard Short-Term Inflation-Protected Securities Index Fund) has adopted policies and procedures reasonably designed to detect and discourage frequent trading and, in some cases, to compensate the fund for the costs associated with it. These policies and procedures do not apply to Vanguard ETF Shares because frequent trading in ETF Shares generally does not disrupt portfolio management or otherwise harm fund shareholders. Although there is no assurance that Vanguard will be able to detect or prevent frequent trading or market-timing in all circumstances, the following policies have been adopted to address these issues: Each Vanguard fund reserves the right to reject any purchase request including exchanges from other Vanguard funds without notice and regardless of size. For example, a purchase request could be rejected because the investor has a history of frequent trading or if Vanguard determines that such purchase may negatively affect a fund s operation or performance. Each Vanguard fund (other than money market funds and short-term bond funds, but including Vanguard Short-Term Inflation-Protected Securities Index Fund) generally prohibits, except as otherwise noted in the Investing With Vanguard section, an investor s purchases or exchanges into a fund account for 30 calendar days (60 calendar days for participants in employer-sponsored defined contribution plans recordkept directly by Vanguard) after the investor has redeemed or exchanged out of that fund account. Certain Vanguard funds charge shareholders purchase and/or redemption fees on transactions. See the Investing With Vanguard section of this prospectus for further details on Vanguard s transaction policies. Each Vanguard fund (other than money market funds), in determining its net asset value, will use fair-value pricing when appropriate, as described in the Share Price section. Fair-value pricing may reduce or eliminate the profitability of certain frequenttrading strategies. Do not invest with Vanguard if you are a market-timer. 24